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April 22, 2014

Risk Management for Homeowners Returning to the Coasts

The biblical story of Noah is currently being retold in movie theaters across the country, but the next “great flood” is not expected anytime soon. Still, some homeowners in the Northeast are still rebuilding after Superstorm Sandy, which hit the region two days before Halloween 2012 with strong winds and a storm surge not witnessed in a very long time.

Sandy reminds us how destructive severe flooding can be. Not only did the storm swamp hundreds of homes along the Long Island, N.Y., and New Jersey coasts, it caused enormous flood losses in Manhattan’s pricey brownstone communities.

Sandy was classified by the National Hurricane Center as an extra-tropical storm, a weather event created by temperature contrasts in the atmosphere, as opposed to a hurricane borne from warm ocean water. Sandy produced a tidal surge that was disproportionately and surprisingly large, exceeding the one-in-500-year flood elevation estimates developed by the Federal Emergency Management Agency (FEMA).

While prognosticators and climate-change advocates debate whether floods will become more common, those of us in the insurance industry can remind customers how damaging they can be. Floods can not only severely damage a home and in some cases completely destroy it, they can breed disastrous health impacts caused by contaminated drinking water, hazardous material spills, disease-carrying insects and rodents and toxic mold. Larger storms have the capacity to cause rivers, streams and lakes to overflow and alter the flood plain map for future generations currently not exposed to such risks.

Norman Heinrich, president of the Miami-based managing general agency WNC Insurance, is a specialist underwriter of flood risks for affluent homeowners. When he evaluates the flood perils at houses along coastlines and rivers, he tugs along detailed flood maps, historical weather pattern data and decades of knowledge to assess the potential for loss.

Norman also is a straight shooter, who tells it like he sees it. “I’m not going to instruct a wealthy person not to build a mansion along the coastline because there is a greater chance of flooding from a tidal surge,” he said. “I understand why such individuals want to have their homes in a beautiful place. Rather, I’m going to help them manage the risk before they build, and buy the best insurance possible afterwards to transfer the threat of loss.”

Learning Lessons

Unlike most people, Norman was not surprised by the flood devastation that occurred in the wake of Sandy. “People want to live by the water and in the mountains because they’re special places,” he said. “Their homes also are more expensive, so when disaster strikes the related costs are going to be sizable.”

Such losses can endure for months, if not years. “I know of people with $5 million homes affected by Sandy who are still living elsewhere while their houses are being repaired,” Norman said. “Ridding the house of damage caused by a flood is not an easy process. We tell homeowners they can live where they like, but be prepared for the consequences.”

To arm oneself from a loss prevention standpoint, homeowners and their financial advisers can get advice from FEMA’s FloodSmart website.

For those with coastal homes, FEMA is in the process of developing new flood hazard data designed to provide additional insight on greater resiliency to future storms. “One thing we learned after Sandy was that the houses protected by sand dunes suffered less damage than those that were not protected,” Norman said.

Of course, even the best loss prevention strategy can falter in the face of a truly catastrophic natural disaster, hence the exceptional prudence in having adequate flood insurance. (Traditional homeowners insurance policies exclude coverage for flood-caused damages.) The government’s National Flood Insurance Program (NFIP) is a great recourse, but the financial limits of protection are $250,000 to cover the structure and $100,000 for the home’s contents, nowhere near what most affluent homeowners would need to defray flood damage expenses.

Fortunately, a robust private flood insurance market has emerged to augment and even replace this insurance capacity, through excess limits of insurance and primary coverage, respectively. This is a good thing, too. Demand for flood insurance is increasing—for obvious reasons. However, the NFIP has accrued $24 billion in debt due to flood insurance claims from a number of recent storms, including Sandy and Hurricanes Katrina and Rita in 2005, according to ratings agency Fitch. This has compelled the federal government (and many state governments) to look for ways to reduce their flood-focused financial subsidies—privatizing flood insurance being a key recourse.

At the same time, premiums for government flood insurance have increased beyond the financial means of many homeowners. “Legislation to scale back the NFIP’s rates was signed recently by President Obama, indicating more federal subsidies will be required to keep the flood program afloat—not less,” said Bob Hartwig, president and chief economist of the Insurance Information Institute. “The new rates will still be less than actuarially sound, creating additional financial burdens for taxpayers. It’s clear this product doesn’t meet the expectations of consumers.”

Bob’s point underscores the importance of a private flood insurance policy—not just for wealthy homeowners but for every homeowner. And just in time, too. According to an analysis by the Department of Homeland Security, if Superstorm Sandy had been a Category 4 storm rather than Category 2, and it made landfall in Manhattan, the damage would have totaled more than $500 billion—quadruple Hurricane Katrina’s financial ferocity.

No one is going to sell their brownstone based on such fears, nor should they. Having experts like Norman evaluate flood risks, advise appropriate mitigation measures and secure comprehensive insurance from a financially strong insurer is the best defense possible against Mother Nature’s increasingly capricious whims. Building an ark would take too long.